LIFE INSURANCE SUITABILITY REVIEWWhose Job Is It?

Metropolitan Underwriters Discussion GroupJanuary 30, 2012

Gary Frank J.D., CLU, ChFCVice President, ComplianceAviva USA

Introduction

The purpose of this presentation is really twofold – (1) to provide the audience with an overview and discussion points on the subject of suitability review of life insurance applications, and (2) to provide an example of a process to perform suitability review for replacement cases.

There has been recent regulatory and legislative activity around the issue of insurable interest in the context of Stranger-owned/Investor-owned life insurance. Premium financing techniques, mortgage-related financing of life insurance and their associated representations are also under the microscope. In addition, there is renewed regulatory concern over portrayal of life insurance as a retirement plan.

Unlike the rules/requirements surrounding annuity applications, most of which are encompassed in the NAIC Suitability of Annuity Transactions Model Regulation, there is no comparable regulation that has been enacted by the states for life insurance purchases. Additionally, only a handful of states have specific regulations that are categorized as “life insurance suitability.” However, most if not all states believe that companies have an obligation to perform basic financial underwriting and many states are increasingly concerned with replacement activity, the suitability of agent replacement recommendations, and the insurance company’s ability to evaluate/monitor such activity.

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Some Preliminary Perspectives

Notable Quotes: • Agent to underwriter – “Field Underwriting? What do you

mean? I thought underwriting was the home office’s job.”

• Client to agent – “Why do they need all this financial information? Your company should be happy I’m buying insurance from them.”

• Sales VP to Advanced Markets Director – “It’s a great concept. The agent believes in it. The client wants it. Why are you challenging it?”

• Chief Underwriter to staff – “Don’t let the perfume of the premium overpower the smell of the risk.”

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Regulatory View – Life Suitability

• Reasonable recommendation standard • Identification of needs/objective• Appropriate amount of coverage • Appropriate premium • Appropriate product• Insurable Interest statutes• Anti-STOLI/IOLI regulations• Replacement regulations

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Life Suitability Basic Considerations

• What needs/objectives were identified by agent?• What is the purpose for the insurance?• Is Insurable Interest demonstrated? • Does the ownership & beneficiary arrangement align

with the indicated purpose? • Is the amount of proposed insurance justified? • Was an acceptable sales/marketing concept used?• If a replacement, is it in the best interests of the

applicant?

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Life Suitability - Other Considerations

• Does the illustration match the stated purpose/objective?• Is the illustration overly aggressive? (Sensitivity testing)• Does the proposed owner/insured/beneficiary

arrangement pose adverse tax consequences?• Does the arrangement pose an unacceptable conflict of

interest for the agent?– Agent as proposed owner or with POA– Agent as trustee– Agent as beneficiary– Agent as collateral assignee

• Are there indications in the file that the applicant may not understand the transaction?

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Life Suitability Review

Traditionally, New Business has evaluated…• Proper completion of application and other forms• Management of workflows around issue and delivery

process/requirements• Issues involving third party ownership (trusts, business

entities, etc)• Proper completion of 1035 exchange process• Proper completion of replacement paperwork and related

requirements

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Life Suitability Review

Traditionally, Underwriting has evaluated…. • Appropriateness of proposed face amount • Insurable interest• Ownership & beneficiary arrangements• General financial underwriting factors• Targeted financial underwriting issues (within prescribed

parameters)• Purpose of the insurance• Whether case represents unacceptable or problematic

marketing concept identified by Legal/Advanced Markets• To some extent, the reasonableness of replacements

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Financial Underwriting

• Analysis of basic financial profile of applicant• Use of financial supplements/questionnaires • Evaluation of economic loss/insurable interest• Too much or too little?• Total in force with all companies• Ability to pay ongoing premiums/source of funds• Does the proposed coverage (type, amount, planned

premium, selected riders, etc.) make economic sense?

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Financial Underwriting (cont.)

How does the analysis differ among: • Personal income replacement cases• Personal specified needs case• Estate conservation• Charitable Giving• Juvenile insurance• Debt repayment• Business continuation• Executive benefits

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Financial Underwriting (cont.)

Home Office relationships/dependencies: • Legal• Compliance• Advanced Markets• Marketing/Illustration Support• Product management• Sales & Distribution

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LIFE SUITABILITY REVIEW PROCESS

A Focus on Replacement Cases

Life to Life Replacements

Key Considerations:• Disclosure of surrender charges on replaced product• Disclosure of new surrender charge period• Discussion of guaranteed/non-guaranteed elements• Existing/proposed face amount of coverage• Existing/proposed annual premiums• Comparison of features/benefits/riders

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Life to Life Replacements

Key Considerations (cont.):• New suicide exclusion, contestable period• Original issue age vs. attained age• Underwriting classification (current vs. proposed)• Matching owner/insured/beneficiary arrangement• Use 1035 exchange process to avoid taxable gain and

carry over cost basis

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Annuity to Life Replacements

Key considerations:• Income tax impact on surrender of annuity contract (No

1035 tax-free exchange)• Identified need for life insurance / objective to be

accomplished• Age of applicant at time of purchase• Can life insurance be issued on standard basis?• Can customer meet obligation of ongoing premium

payments?• Has original need/objective for annuity disappeared?

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Life Suitability Review Project

• Emphasis on replacements• Primary focus on documentation• Secondary focus on evaluation/monitoring• A more targeted, simplified process, compared to

annuity suitability review• Revised Agent’s Report

– Completion in good order– Replacements Review Team– Escalation triggers

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Revised Agent’s Report

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1. a. Does the proposed insured have any life insurance or annuity contract(s) currently active with our company or any other company? Yes No(If Yes, and if required by state regulation, any Replacement Comparison, Notice or Statement must accompany this application.)b. Will any annuity or life insurance presently or recently in force be replaced or changed by this policy applied for?. . . . . . . . . . . . . . Yes Noif 1b is answered “yes”, please complete the following questions:i. What is the primary reason for the replacement? __________________________________________________________ii. Are you the writing agent on the current policy? . . . . . . . . . . . . . . . . . . Yes Noiii. When was the current policy issued? _____________________________________________________________________iv. With what underwriting classification was the current policy issued?__________________________________________________________v. What are the current/proposed annualized premiums? ____________________________________________________________________vi. What are the current/proposed death benefit amounts? ___________________________________________________________________vii. What are the remaining surrender charges on the current policy? ___________________________________________________________viii. Have you discussed/described the surrender charges and surrender charge period regarding the proposed policy? . . . . . . . . Yes Noix. If values from an existing annuity contract are being used to pay premiums on the proposed policy, how has the original objective of the annuity contract changed?_____________________________________________________________x. If values from an existing annuity contract are being used to pay premiums on the proposed policy, have any tax implications been explained to the customer? . Yes Noxi. 1035 Exchange (attach required forms) External Internal __________________________________________________________

Revised Agent’s Report

Confirmation of completion in good order:• Data Entry staff’s responsibility• Obtain missing information through appropriate contact• Resolve conflicting information through appropriate

contact – Application and agent’s report conflict– Q 1.b answered “no” but replacement form or 1035

exchange transmittal submitted w/app

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Revised Agent’s Report

Question 1.b.i (primary reason):• Looking for substantive reason(s)• “Better product” or “Upgrade” insufficient• Generally handled w/request for additional

information/description• No escalation required if reason is plausible, does not

conflict w/replacement form, and recommendation appears reasonable

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Revised Agent’s Report

Question 1.b.ii (writing agent on current policy):• This question’s primary purpose is to identify a trend

(significant replacement activity w/question answered “yes”)

• Important related questions are 1.b.i, 1.b.iii and 1.b.vii.• If a trend is discovered (e.g. 5 or more similar

transactions within 12 months) referral to Escalation Team is appropriate

• Possible referral to Agent Monitoring

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Revised Agent’s Report

Question 1.b.iii (current policy issue date):• Relevant in relation to other responses• Recent issue date could mean substantial surrender

charges• Possible relevance to churning/twisting (i.e. multiple

replacements with recent issue dates)• Remote issue date could indicate existing policy is quite

healthy or even in “paid-up” status• Remote issue date (on other hand) could bolster reason

for replacement

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Revised Agent’s Report

Question 1.b.iv (current policy underwriting class):• A key inquiry• Particularly relevant if Underwriting considering “adverse

action” on proposed coverage• Not necessarily concerned with preferred (current policy)

and standard issue (proposed policy)• Table ratings require additional inquiry if current policy

standard• Substantial rating (Table C or >) requires Life Policy

Review

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Revised Agent’s Report

Question 1.b.v (premium comparison):• Comparable face amounts but significantly higher

premiums on proposed coverage• Request explanation – could be that client objectives

justify higher premiums • If explanation insufficient, request in force ledger• If in force ledger indicates no benefit (or, in fact, the

opposite), refer to Escalation Team)

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Revised Agent’s Report

Question 1.b.vi (face amount comparison):• Proposed face amount substantially lower

– Request explanation – could be plausible change in needs/objectives

– If no/insufficient explanation provided, refer to Escalation Team

• Proposed face amount substantially higher– Request explanation - could be plausible change in

needs/financial condition– Could be effort to consolidate smaller policies– Look at sufficiency of planned premiums

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Revised Agent’s Report

Question 1.b.vii (current policy surrender charges):• Anticipate no answer or “unknown” response• If current policy issued with last five years, notify contact

that information is required (if U.L. chassis product)Question 1.b.viii (discussion of proposed policy surrender

charges):• If answered “no,” request explanation why surrender

charges (amount/duration) on proposed policy not discussed

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Revised Agent’s Report

Questions 1.b.ix and 1.b.x (annuity values):• Looking for brief substantive explanation (e.g.):

– Customer has concluded they do not need the annuity for income

– Customer withdrawing small percentage of annuity accumulation to maximize overall value to heirs

• “Wealth transfer” is insufficient response to 1.b.ix (but may be sufficient response to 1.b.i)

• If answer to 1.b.x is “no,” request explanation from agent/contact

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Revised Agent’s Report

Questions 1.b.xi (1035 exchange):• Could be plausible explanation if left blank or answered

“N/A” – typically if no taxable gain upon surrender of current policy

• Request explanation • If lump sum proceeds from surrendered policy creates a

MEC, request justification from agent/contact• If justification does not make sense, refer to Escalation

Team

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Revised Agent’s Report

Review of Agent’s Report:• Replacement Review Team’s responsibility• Evaluate reasonableness of recommendation• Consider additional information – in application,

replacement form, cover letter, etc.• Examine sufficiency of responses• Identify any red flags• Resolution via clarification from agent/contact

• Resolution via escalation team

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Revised Agent’s Report – Red Flags

Key “Red Flags” include:• Proposed face amount substantially lower• Proposed premium substantially higher • Ambiguity as to primary reason for replacement• Substantial surrender charges on current policy• Information provided indicates no demonstrable benefit

(or, in fact, indicates the opposite)• Proposed policy will be issued with table rating or

exclusion rider• 1035 process not used

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Escalation Triggers

• Information in file indicates replacement would likely be detrimental to customer

• Current coverage issued standard or better, proposed coverage issued w/Table rating

• Substantially lower coverage w/o adequate explanation• Substantial conflicting information in file not resolved

through explanation from agent/contact• Significant replacement activity identified• Agent/contact generally uncooperative

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General Reminders/Pointers

• Primary goal is to conduct inquiry into replacement transactions and document responses

• Majority of agents exercise care when making replacement recommendations

• Red flags do not = decline or even escalation• Red flags do = request for additional information • Looking for coherent, plausible explanations when

further information requested• Referral to Escalation Team relatively infrequent

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Life Suitability Review - Concluding Remarks

• Clear communication and cooperation among Home Office Departments is critical

• Include the topic of life insurance suitability in agent training venues and field communications

• Encourage agents to “tell the story” (the lost art of the cover letter)

• Make internal sales staff and field aware of heightened regulatory scrutiny of replacements in market conduct examinations and agent investigations

• Anticipate new regulation in this area• Suitability review is a key component for persistent &

profitable business.

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QUESTIONS & COMMENTS?

Thank You!